Forget Penny Stocks! Invest in These Dividend Stocks Instead

When looking for dividend paying stocks, many investors make the mistake of focusing on those with the highest-yielding payouts. However, high-yield isn’t always the best route to go. It could be an indication a company is growing at a snail’s pace, stagnant, or worse: at risk of needing to cut its shareholder payout to be able to pay its bills.

a box on a table: Forget Penny Stocks! Invest in These Dividend Stocks Instead

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Forget Penny Stocks! Invest in These Dividend Stocks Instead

In contrast, many investors pass up lower-yielding stocks with a track record of increasing their dividends over time. That can be a powerful generator of wealth, as a rising dividend is usually an indication of a healthy and growing business. Three Fool.com contributors think Target (NYSE: TGT), American Tower (NYSE: AMT), and KLA Corp (NASDAQ: KLAC) fit this bill. Here’s why.

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A big-box store for the 21st century

Nicholas Rossolillo (Target): Faced with e-commerce disruption like the rest of the brick-and-mortar retail industry, Target embarked on a journey of investment and discovery a few years ago. Specifically, the company started investing in the ability to fulfill customer orders in a variety of ways (including the acquisition of delivery upstart Shipt), reimagined the future use of its stores (as a fulfillment center, not just a shopping destination), and launched numerous in-house brands in apparel and home goods. The decision was panned by many shareholders because it meant profit margins were going to take a hit.

Obviously it was a prescient decision given the year we all just endured. Target’s revenue increased 19% year over year through the first nine months of its fiscal year 2020, and recently indicated comparable-store sales (an average of customer traffic and size of purchase) increased 17% year over year in November and December. Specifically, curbside pickup and Shipt sales increased 500% and 300% during the busy holiday shopping season. But more importantly, all of this new activity at the big box store means the bottom line is on the rise again and it’s paying off in spades.

Over the last trailing-12-month stretch, Target’s operating profit margin was nearly 6.7%. That compares to just 5.5% two years ago when the company was still in the midst of heavy spending to update its operations. Rising sales and profit margin is exceptionally good news. And Target reports its in-house apparel and home goods brands remained in growth mode in 2020, while average industry sales in these segments declined. That means Target is winning lots of new market share. This story sounds a lot more like a younger e-commerce company than it does a legacy retailer. Give credit to all the behind-the-scenes work Target has done on its software and operating processes.

Long story short, the company’s recent adjustments to the new digital normal means it’s able to easily pay its dividend, which currently yields 1.5% a year. It also keeps its track record of increasing that dividend alive — including through the last two economic crises (the current one, and the financial crisis of 2008–2009). This isn’t the most exciting name in e-commerce, but there’s a lot to like here for investors looking for a balance of growth and rising income.

a close up of a box: A grocery cart with a mask over the front of it and shipping boxes sitting on top of a laptop.

Squeezing dividend checks out of 180,000 cell towers

Anders Bylund (American Tower): Real estate investment trusts, also known as REITs, are exempt from paying corporate taxes in exchange for a promise to pay out at least 90% of their taxable income in the form of dividends. This tax-saving strategy leads to several shareholder-friendly advantages, including generous payouts and reliable dividend policies. REIT stocks also have to generate most of their revenue from managing, renting out, leasing, and otherwise taking advantage of their real estate assets.

That might not sound like a common idea in the tech sector, but many types of technology businesses have found ways to fit into the REIT model. Today, I’m talking about cell tower manager American Tower, which qualifies as a REIT by leasing out access to 180,000 towers and 1,800 distributed antenna systems across five continents.

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True to the REIT strategy, American Tower consistently pays out approximately 90% of its taxable income as dividends every year. As the taxable income rises over the years, so do the payouts:

chart, line chart: AMT Dividend

© YCharts
AMT Dividend

Many companies with dividend payouts rising that fast would naturally provide rising dividend yields as well. But American Tower’s stock price also keeps rising thanks to the company’s proven success and expanding growth options. At the moment, American Tower’s fastest-growing revenue streams are found in developing economies across Africa and Latin America. At the same time, the company enjoys a stable foundation of high-quality contracts with the three largest North American cell networks, whose contracts add up to represent roughly half of American Tower’s annual sales.

So the dividend yield isn’t skyrocketing. Instead, it tends to bounce around in the 1.5% to 2% range. Today, the yield stands at 2%. But it’s hard to complain about low dividend yields when the stock is soaring, and it’s the rare combination of fantastic payouts plus strong stock returns that makes American Tower such a great ticker to own for long-term investors.

Dependable dividend growth in the booming semiconductor sector

Billy Duberstein (KLA Corporation): These are great times for the semiconductor equipment sector. After a trade war-induced downturn followed by the COVID-19 pandemic, which caused chip companies to pull back on supply either by choice or due to restrictions, demand is now booming, and there are chip shortages everywhere, from PCs to autos.

What does that mean? A big ramp in semiconductor spending, especially from leading semi foundry Taiwan Semiconductor Manufacturing (NYSE: TSM). On its fourth-quarter earnings call, TSM announced a massive ramp in capital expenditures for 2021, which should boost results for all semiconductor equipment companies.

That includes KLA Corporation, the dominant leader in process control machines, which inspect wafers and reticles for imperfections. That technology is needed in greater and greater amounts at smaller chip nodes, as manufacturing gets more precise and difficult. The smaller and more advanced the chip, the more essential KLA’s machines are.

KLA just reported earnings last week and wrapped up a great calendar 2020, with revenue up 15%, margin expansion driving a 28% increase in operating income, 32% EPS growth, and 44% free cash flow growth. KLA is also returning that cash to shareholders in the form of healthy share repurchases and dividends. In fact, KLA’s dividend per share has increased at a 15% average growth rate for the past 15 years — more than sextupling in that time! Moreover, management said results are currently tracking higher than its 2023 targets outlined last investor day.

KLA is one of the safer semi equipment picks in that its machines tend to be a bit less cyclical than rivals in etch and deposition. That’s because even in down cycles, while semi foundries tend to pull back on capacity expansion, they do generally tend to continue with node transitions to stay competitive. KLA’s machines are especially important to node transitions, so it’s generally less affected. At 22 times next year’s earnings estimates and at a 1.25% (and growing) dividend yield, KLA is still a solid value, with strong competitive position in the booming semiconductor sector.

Anders Bylund owns shares of American Tower. Billy Duberstein owns shares of KLA-Tencor and Taiwan Semiconductor Manufacturing. His clients may own shares of the companies mentioned. Nicholas Rossolillo owns shares of Target. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends American Tower and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.